CP beats noisy Q2/18 expectations; New Day, New Opportunity

“We don’t manage the company from an OR perspective….We’re returns focused”

/Canadian Pacific CEO Keith Creel (in response to innumerable questions about the second half OR expectations)

Good quarter in a rather noisy time: CP beat expectations by a nickel, and grew by 14% YOY despite the well-publicized Q2 labor situation culminating in a near then a real strike….In that regard the 7% revenue growth on 4% RTM growth (although I much prefer actual loads: +2%) wasn’t a bad performance at all. CP’s OR was up 140bps to 64.2% - CFO Velani stated it would have been flat without the labor disruptions – and that included fuel surcharge lag effects, and training (“prepaying investments”) costs. Speaking of investments, I was pleased to see CP raise their own Capex number In fact, CP seems very confident in H2/18 – not by itself (despite the tenor of the webcast Q&A) but as a start to a new growth period for CP, which after a rough start, has been on a roll:

C-49 passage into law in Canada – which, while not without issues (grain price increases capped at +2.8%; longer reciprocal switching limits) allows for a significant investment in grain productivity

Labor peace – assuming the last ratification – that actual focus on the “new day” discussion by Creel; the new contacts don’t have major financial impacts but do allow for more “flexibilities” and allow for a more fruitful ongoing relationship (following the Post-Hunter Textbook)

Rather minimal direct disruption from the global trade debacle (more fears of the macro impact); in fact CP’s lumber business, the very first tariff-targeted commodity, grew 4% in Q2/18. The selected commodities are grain/metals/lumber/finished vehicles – no mention of international intermodal (maybe because its revenues were up 16% in the Q)

A healthy intermediate term outlook – CBR, potash, intermodal, and depending on the current crop but certainly thereafter, grain….

Land sales seem to be picking up, with a large one expected in Q4

A tight overall transportation network (Creel’s statement that “it was a good time to be in railroading” makes it 2 for 2 so far this earnings period) – pricing was up at or above the high-end of their proffered range of 3-4%, with a fifth of their book to be repriced in H2/18

There were some operational issues, not much discussed on the call. Creel stated that the CP “network was extremely fluid”, but like views of summit success, the numbers suggest something a tad different. While safety was superb (P/I down 7%, the accident rate down fully 32%), dwell was up 16%, and perhaps getting worse (YTD was +14%). Of course the labor issues could be all of that explanation….Velocity declined 8% for the quarter as well as for the YTD. Train length was up 2% on the other hand….

CP’s October 3-4 Investor Day (rescheduled from the time of the strike/threat) will be, of course, important. In fact, CP’s new timing might be fortuitous – timed with the end of the current buyback (and already questions about leverage and major programs), with new capex opportunities (CP raised the 2018 target from C$1.35B-1.5B to $C1.55B – and even hinted at $C1.6B!), with labor issues receding, with a new Canadian regulatory regime, and with a macroeconomic and transportation/capacity wind solidly at their backs